Lihir: Buy, Hold Or Take Profits?

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This story features NEWCREST MINING LIMITED, and other companies.
For more info SHARE ANALYSIS: NCM

By Greg Peel

The timing of Newcrest Mining's ((NCM)) “first” offer for rival Lihir Gold ((LGL)) was a little bit cheeky. Not only did it catch Lihir effectively without a CEO, it came just after the March option expiry. A lot of market traders had loaded up on call options in readiness for what has long been regarded inevitable but had failed to roll over into expensive June contracts given doubt had begun to creep in.

So there are a lot of people out there who had the right idea but failed to profit. Now it's a case of do I buy if I don't have Lihir already or do I sell if I do?

In every takeover play the usual rule is the first bid is never the last, just as it is in life. Newcrest has not announced its bid to be “final”, although in theory this is the second bid following a bit of an unofficial approach in February. The current scheme of arrangement has a nine month ban on a “hostile” bid as the next approach, so with Lihir management rejecting this bid Newcrest has to either sweeten with a smile or wait it out before pushing Lihir's shareholders to respond.

It is important to note that 50% of either company's register represents owners of both stocks. Hence the decision from shareholders will be one of weighing up the pros and cons rather than just holding out for a better price. What you gain on the swings you lose on the roundabout.

Based off the closing price mark ahead of the bid, securities analysts value the cash/scrip offer at $3.87 or a 28% premium. Another rule in takeovers is you usually need at least a 30% premium to warrant taking control of a company, so Lihir's first response was to claim undervaluation just as the script might suggest.

At this price, the deal would be earnings accretive for Lihir shareholders, but value dilutive. However, if Newcrest were to sweeten by too much then the positions would reverse. In other words, there's a neutral point at which the deal is best for both parties in price terms.

Deutsche Bank considers that value to be $4.30, which is a tad over 10% above the existing bid notwithstanding share price movements in the meantime. RBS agrees that a “bump” of 5-10% could be enough to get the deal over the line. JP Morgan believes Lihir would be looking at more like $4.50 to be a seller and Macquarie suggests the board should look to engage at exactly that price.

Macquarie nevertheless suggests the acquisition of Lihir is not vital for Newcrest. But given gold discoveries are becoming more and more rare and Newcrest is increasing its copper exposure, the company runs the risk of seeing its gold revenues slip below a proportion of 30%. At that point it would become a copper miner with some gold rather than a gold miner with some copper, or so popular opinion goes.

This is important, because gold miners attract what JP Morgan calls a “strange” premium over base metal miners. To that end, Macquarie believes Newcrest is sufficiently attracted to Lihir's world class gold reserves to pay over the odds and so the analysts have increased their target price to $4.50.

Credit Suisse does not believe Newcrest needs to improve its offer. The reason is because it believes Lihir has been upsetting shareholders by keeping them out of the decision making process to date. CS suggests that in shareholder meetings coming up the Board will be told in no uncertain terms that shareholders should have been allowed to vote on a rejection of the Newcrest bid and that shareholders would not have rejected it. CS also a month or so ago unfortunately dismissed a Newcrest bid as not likely for a while yet.

There is little doubt among analysts that a merged Newcrest/Lihir is an enticing proposition, providing Lihir with the diversification it needs and Newcrest with the extra gold reserves it needs. The question is however, will someone global come in over the top with a counterbid for Lihir, such as a Barrick or Newmont for example, given every major gold miner is short on new projects? And for that matter, might someone perhaps move on Newcrest before it can move on Lihir? Because if the two do merge, that entity will be too big for anyone else to take over.

RBS doesn't think so, but most brokers aren't ruling a counterbid out. Thus Newcrest has a decision to make. Does it sweeten the deal a little bit (as is the nature of the takeover game anyway) to ensure an acceptance, or does it wait nine months to go hostile in the belief Lihir's shareholders would have accepted if they'd been given the chance, thus risking a counterbidder for Lihir or even a hostile attack on itself?

Were the bid to fail, and no counterbidder to emerge, there's 30% downside now for Lihir's share price. A sweetener provides perhaps 5-15% upside. Were Newcrest to wait it out, creeping disiniterest would also mean more downside than upside. On this risk/reward scenario, both RBS and Citi have now downgraded Lihir to Hold from Buy. GSJB Were, Macquarie, JP Morgan and Deutsche are all sticking with Buy, suggesting the stock is in play. UBS was already playing the middle ground with a Hold rating while Credit Suisse is sticking to Sell (Underperform) given it does not see a bid improvement.

The interesting element to all of those, going back to my opening line about it being a “cheeky” bid, is that the announcement of a new and well-respected CEO along with a new reserve upgrade last week would have pushed Lihir's share price up anyway, but that value is now lost in the subsequent share price reaction.

What is confusing for investors, other than differing analyst views on a sweetener, is the sheer range of target prices. Most brokers have shifted their targets up to represent where the value point now lies in the battle. This results in the average target in the FNArena database rising from $3.77 to $4.14. But Credit Swiss is sticking to $3.65, and RBS to $3.73, while Macquarie has lifted from $3.80 to $4.50 for example and JPM has kept its already established target of $4.82.

So any investor holding Lihir will simply have to make a decision on whether profit made to date is good enough, thank you very much, or whether a bit more is worth risking.

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